 "Mix assets for alpha returns")
Investors are aware that diversification of investments helps in mitigation of risk and steadying their returns. However, after diversification what should be their expected return from an individual asset class and from the portfolio is a tricky question.
Typically, the retail investors look at fixed deposits, bonds, equities, equity mutual funds, gold and real estate for investments. All these asset classes have different risk profile and returns. So what should be the return from the individual asset class and from the portfolio. This is an important aspect and needs to be identified before embarking on the investment.
Let us look at these asset classes and the return expectation from them.
Bank fixed deposits: Placing deposits with banks is most preferred instrument by the retail investors. In India, public sector banks are considered to be the safest investment destination as they have sovereign holdings.
The current interest rate for one year deposit offered by State Bank of India(SBI) is 9 per cent. The rate offered by SBI is considered as a benchmark by most of the banks and accordingly rate offered by them is +/- 0.25 to 0.50 per cent/. In case any bank is offering more than 0.50 per cent than this benchmark rate, the investor needs to look at the profitability and solvency of such banks. Deposits up to Rs 1 lakh with commercial banks and specified co-operative banks is guaranteed by Deposit Insurance Guarantee Corporation of India. The deposit from Post office and govt savings bonds earn lower than bank fixed deposits as they are most secured.
Bonds and debentures: A fundamental difference between bank fixed deposit and bonds is that fixed deposit is not transferable and hence cannot be traded, however bonds are transferable and can be traded. As a result, you can earn capital appreciation in case interest rates go down and you hold a bond with higher interest rate. The typical return from bonds is 0.50 to 1 per cent higher than long term bank fixed deposits. In case they are issued by private Non-Banking Financial Companies, it can be 2 to 3 per cent higher due to their higher risk profile.
Equities: Equities as an asset class are risky in nature. Hence one expects higher returns as compared to relatively safe instruments such as bonds and fixed deposits. Return expectations in case of equity can be linked to the time horizon. For example if you want to hold the investment for say 1 year, you can have a return expectation of say 10 to 15 per cent. If you wish to lock it for 5 years, you can look at an absolute return of 50 to 60 per cent (annual approx. 12 to 15 per cent). If the time horizon is higher than that then you can look for annual return of say 15 to 20 per cent. Also this return expectation should be in line with the general market returns that is the return generated by Sensex or Nifty. The one year return for Nifty is roughly 11 per cent and five year annual return is about 23 per cent.
NIFTY
Equity mutual funds: The returns from equity mutual funds will be required to be slightly moderated as they have a diversified portfolio as well as have to keep certain percentage in cash or cash equivalent. So if the expectation from pure equity investment is say 15 per cent then the return from equity oriented mutual fund could be about 12 per cent.
Real estate: Investment in real estate has to be for long term due as its incidental costs like brokerage and stamp duty, are high. The return from real estate can be by way of rental income or capital appreciation or both. It is important to note that the house in which you reside should not be considered as investment as it is for self consumption. Usually the rental yields differ in metro and non metro areas. Metro areas give a rental yield of approx. 3 to 5 per cent. Whereas, that in non metro areas, it can be slightly lower in non metro areas. Capital appreciation can be in the range of 12 to 18 per cent annually. One important aspect to consider is that property is less liquid as compared to other assets.
Gold: Typically return from gold is linked to inflation. When there is high inflation, the gold price increases and vice versa. When equity market is bullish, the gold prices are subdued. However when the market is bearish, the gold prices show an increasing trend. Ideally a return expectation of 10 to 12 per cent is reasonable.
Portfolio returns: The return from the portfolio is a combination of all the investment that you have made and been able to liquidate. A return of 10 to 12 per cent in today's world is what can look at.
In case the markets are very bad, this can be difficult to achieve too.
STRATEGY
Typically, the retail investors look at fixed deposits, bonds, equities, equity mutual funds, gold and real estate for investments. All these asset classes have different risk profile and returns. So what should be the return from the individual asset class and from the portfolio. This is an important aspect and needs to be identified before embarking on the investment.
Let us look at these asset classes and the return expectation from them.
Bank fixed deposits: Placing deposits with banks is most preferred instrument by the retail investors. In India, public sector banks are considered to be the safest investment destination as they have sovereign holdings.
The current interest rate for one year deposit offered by State Bank of India(SBI) is 9 per cent. The rate offered by SBI is considered as a benchmark by most of the banks and accordingly rate offered by them is +/- 0.25 to 0.50 per cent/. In case any bank is offering more than 0.50 per cent than this benchmark rate, the investor needs to look at the profitability and solvency of such banks. Deposits up to Rs 1 lakh with commercial banks and specified co-operative banks is guaranteed by Deposit Insurance Guarantee Corporation of India. The deposit from Post office and govt savings bonds earn lower than bank fixed deposits as they are most secured.
Bonds and debentures: A fundamental difference between bank fixed deposit and bonds is that fixed deposit is not transferable and hence cannot be traded, however bonds are transferable and can be traded. As a result, you can earn capital appreciation in case interest rates go down and you hold a bond with higher interest rate. The typical return from bonds is 0.50 to 1 per cent higher than long term bank fixed deposits. In case they are issued by private Non-Banking Financial Companies, it can be 2 to 3 per cent higher due to their higher risk profile.
Equities: Equities as an asset class are risky in nature. Hence one expects higher returns as compared to relatively safe instruments such as bonds and fixed deposits. Return expectations in case of equity can be linked to the time horizon. For example if you want to hold the investment for say 1 year, you can have a return expectation of say 10 to 15 per cent. If you wish to lock it for 5 years, you can look at an absolute return of 50 to 60 per cent (annual approx. 12 to 15 per cent). If the time horizon is higher than that then you can look for annual return of say 15 to 20 per cent. Also this return expectation should be in line with the general market returns that is the return generated by Sensex or Nifty. The one year return for Nifty is roughly 11 per cent and five year annual return is about 23 per cent.
NIFTY
Equity mutual funds: The returns from equity mutual funds will be required to be slightly moderated as they have a diversified portfolio as well as have to keep certain percentage in cash or cash equivalent. So if the expectation from pure equity investment is say 15 per cent then the return from equity oriented mutual fund could be about 12 per cent.
Real estate: Investment in real estate has to be for long term due as its incidental costs like brokerage and stamp duty, are high. The return from real estate can be by way of rental income or capital appreciation or both. It is important to note that the house in which you reside should not be considered as investment as it is for self consumption. Usually the rental yields differ in metro and non metro areas. Metro areas give a rental yield of approx. 3 to 5 per cent. Whereas, that in non metro areas, it can be slightly lower in non metro areas. Capital appreciation can be in the range of 12 to 18 per cent annually. One important aspect to consider is that property is less liquid as compared to other assets.
Gold: Typically return from gold is linked to inflation. When there is high inflation, the gold price increases and vice versa. When equity market is bullish, the gold prices are subdued. However when the market is bearish, the gold prices show an increasing trend. Ideally a return expectation of 10 to 12 per cent is reasonable.
Portfolio returns: The return from the portfolio is a combination of all the investment that you have made and been able to liquidate. A return of 10 to 12 per cent in today's world is what can look at.
In case the markets are very bad, this can be difficult to achieve too.
The writer is a freelancer
STRATEGY
- Have a long-term horizon for investments.
- Have a realistic return expectation. By having higher return expectations there are chances you may lose your capital
- Consider the tax impact while calculating returns. It can impact your net returns.
- For example, short-term capital gain is high in case of equities, whereas, long-term capital gains are exempt from tax
- Do proper due diligence to find the correct return
- Have a system for evaluating performance of investment at regular intervals and take corrective steps